Japan

World growth over the past three years has fallen below its five-year rate and below its very long-term one, as chart one shows. It seems therefore reasonable to assume that we are experiencing what is at least a cyclical downturn. But the chart also shows that the trend since 1980 or 1990 seems to be a rising rather than a falling one. It doesn’t therefore seem to me reasonable to assume that the world is about to experience of the sort of longer -term slowdown that can reasonably be described as secular stagnation, though of course this may happen. Read more

On current trends, Japan’s gross domestic product will grow faster than that of the US over the next 10 years. As Japan’s population is expected to fall and that of the US to rise, the relative improvement in living standards will be even greater. This will be denied by many economists and journalists, for whom Japan’s relative weakness is an item of faith.

The habit of looking at the change in GDP and assuming that this provides a good guide to the success of an economy is to blame for the prevalent view. It is a deeply embedded and near-automatic assumption that has blinded commentators to Japan’s relative economic success. In the recent past, demography has posed a far greater challenge for Japan than for other G5 countries but that has now changed. If, in other respects, Japan can maintain its past progress over the next 10 years, then the improvement in its demographic balance will boost the growth of its GDP and its living standards. Read more

Conventional wisdom, those wrongheaded comments that sound authoritative, is flourishing. Much comes from seeing gross domestic product as the measure of economic success. As Japan’s GDP has grown slowly this has led the unreflective to assume that the country’s performance has been poor. As readers of this blog will know, this seems to me to be nonsense. GDP is a fair measure of a country’s economic power, but changes in GDP per head provide a better guide to the progress of a country’s welfare and GDP per person of working age is a better guide to the success of economic policy. The number of Japanese aged 15 to 64 has been falling and this has limited the country’s ability to expand its GDP. If the changes in GDP per person in major developed countries are compared, Japan stands out for its success rather than its failure.

I am by no means alone in pointing this out; the former Bank of Japan governor, Masaaki Shirakawa has also regularly done so. Judging, however, by comments in the financial press we seem to have been talking to brick walls. The damage done from seeing GDP as a valid measure of economic success has been magnified by an association that is commonly made between low growth and deflation. It is widely believed that Japan’s economy has performed poorly and that this has been caused by deflation. It would be more reasonable, though not much more, to praise deflation for the relative success of Japan’s economy. Read more

Quantitative easing involves buying bonds and this increases the Bank of Japan’s assets and the monetary base which, depending on the precise definition used, is nearly the same thing. As a result of the BoJ’s aggressive QE policy, its balance sheet has grown from 30 per cent of gross domestic product at the end of 2012 to 60 per cent at the end of 2014. Over the past year it has grown relative to GDP by 14 per cent (chart one). This compares with a fiscal deficit of around 8 per cent of GDP. Japan’s central bank is thus buying more than 100 per cent of the securities issued by the government to finance the deficit. Read more

Japan’s gross domestic product shrank in the third quarter of 2014 at 1.6 per cent per annum over the quarter and 1 per cent over the previous 12 months. This disappointed the stock market, which fell by more than 2 per cent. It then recovered almost fully the next day on the news that Prime Minister Shinzo Abe had called a snap election, designed to give him a mandate to postpone the increase in consumption tax otherwise due in October 2015.

Governments can boost demand by increasing expenditure or by cutting taxes. Disappointing GDP data do not therefore provide much reason for gloom unless the government appears unwilling to boost demand or the data reflect a problem of supply rather than demand. Read more

Japan cannot put its economy on to a sustainable path unless it reforms its corporation tax system. Fortunately, this is now under active discussion. Unfortunately, it is far from clear that the right changes will be made.

One sector of the economy cannot lend unless another borrows. The sum of the net lending and net borrowing in an economy must therefore equal zero. Japan’s government is a huge borrower and, if this is to be brought down to a sustainable level, the net lending of other sectors must come down by an equal amount. As chart one shows, it is the corporate sector which has moved into massive cash surplus since 1988, when Japan’s fiscal balance moved into a structural deficit. It is therefore the corporate sector which must take the brunt of any fall in government borrowing through a similar decline in the sector’s net lending. Current tax arrangements and regulations are the key cause of the massive cash surpluses run by companies which must be brought down if the fiscal deficit is to be reduced to manageable proportions. Read more

Abenomics, the term given to the reform package Japanese prime minister Shinzo Abe launched to revive the country’s economy, is based on two myths. One is that the economy has performed badly and the second is that this non-existent failure has been due to deflation. Despite its lack of intellectual justification, the attempt to stop deflation has been a success as the accompanying rhetoric and monetary policy have produced yen weakness. This was an essential step towards solving Japan’s fiscal problem and, as the rhetoric has been about deflation rather than devaluation, the dramatic weakness of the currency has been achieved without international opprobrium.

Over time the devaluation should result in an improved current account. This will allow the fiscal deficit to fall while the economy moves ahead, but it is not enough on its own. The other essential is to reduce the cash flow surplus of the business sector. Having achieved success in step one, largely by accident, there is a chance that Abenomics will succeed in step two. If it does, it is again likely to be an accident. Read more

In my last blog I emphasised the importance of foreign investors for the Tokyo stock market, but suggested that their future behaviour was either unpredictable or momentum based. If the latter assumption is correct, foreigners are likely to amplify rather than lead changes in the market’s direction and to assess its prospects we therefore need to look at the other participants. Read more

Japan increased its consumption tax from 5 per cent to 8 per cent on April fools’ day. It seems unlikely that the negative impact of this on demand will be totally offset by other changes in the budget. There is therefore a risk that Japan’s economic growth this year will fail to match its trend rate (ie, its economy will grow less than its potential). The most likely way that this will be avoided is for Japan’s exports to pick up.

Comments are flying around about whether inflation or deflation is the greater risk. This is almost invariably interpreted as asking which is the most likely and therefore misses the central point. Inflation is a much greater risk – not because it is more likely but because its consequences are far worse.

Deflation has been demonised. It has been harmless or even beneficial in Japan. While I think it would hurt the eurozone, its impact would be mild and easily reversed – or it would be if German economic policy was not so obstinately foolish. Inflation poses a much more serious problem, particularly in Japan, the UK and the US. Read more

Abenomics – the policy endorsed by Shinzo Abe, the Japanese prime minister – aims to raise the country’s growth by getting rid of deflation. It is based on two myths. The first is that the economy has done badly and the second is that it has been hurt by deflation.

The first myth comes from judging a country’s economic success by its gross domestic product. Japan has a falling and ageing population. If allowance is made for this, Japan has been the most successful of all Group of Five leading economies. It is the country whose GDP at constant prices per person of working age has grown most rapidly, at least since 1999. Read more

Andrew Smithers

Economics and markets

About this blog

About Andrew

Blog guide

Hello!

I’m Andrew Smithers; I studied economics at Cambridge and used to run the fund management business at S G Warburg which became Mercury Asset Management and is now BlackRock.

I set up Smithers & Co in 1989 as an economics consultancy. Much of the comments on economics and markets that I read as a fund manager struck me as nonsense and I have had great fun in pointing this out to clients over the years.

I now have the opportunity to disseminate my views more widely and hope that this will amuse and inform readers.

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Andrew Smithers, Chairman, founded Smithers & Co., a leading advisor to investment managers on international asset allocation, in 1989.

Prior to starting Smithers & Co., Andrew was at S.G. Warburg from 1962 to 1989. He has been a regular contributor to the London Evening Standard, Sentaku Magazine and the Nikkei Veritas. His OpEd pieces are included periodically in the Financial Times.

He is co-author of Valuing Wall Street with Stephen Wright, published in 2000, and Japan’s Challenges for the 21st Century with David Asher, published in 1999. His book Wall Street Revalued - Imperfect Markets and Inept Central Bankers was published by John Wiley & Sons, Ltd. in July, 2009. He is also the author of Chapter 6, “Can We Identify Bubbles and Stabilize the System?” in The Future of Finance: The LSE Report, published by The London School of Economics and Political Science in September, 2010. His latest book is The Road to Recovery: How and Why Economic Policy Must Change (2013).

Andrew is a Trustee of the Daiwa Anglo-Japanese Foundation and a Fellow of CFA (UK).